The Case Against Pay Transparency

Calls for pay transparency as a cure for pay discrimination are abundant. As the argument goes, if everyone knows everyone else’s pay level, patterns of discrimination will be broadcast, so pressure to remedy them will mount. But the claims of pay transparency’s beneficial powers go far beyond remedying pay discrimination, extending to boosting an organization’s overall morale and performance.

Far from a panacea, pay transparency is a double-edged sword, capable of doing as much — or more — damage as good. Broadcasting pay is as likely to demoralize as it is to motivate. While pay transparency may accelerate attention being paid to remedying pay discrimination, managers should consider moves toward transparency with their eyes wide open.

Pay transparency does provide more information with which to assess the fairness of pay allocation. But herein lies the challenge. In most work settings individual performance is not easily observed, in part because our performance is a joint product that reflects both our own effort and that of many others. This seems to give us wide latitude to exaggerate our performance and our contributions to the organization — and to do it a lot. Some years ago I asked a group of 700 engineers from two large Silicon Valley companies to assess their performance relative to their peers. The results were startling. Nearly 40% felt they were in the top 5%. About 92% felt they were in the top quarter. Only one lone individual felt his or her performance was below average. This inflated sense of self-worth makes the organization’s task of linking performance to pay tremendously difficult.

Widely publicizing pay simply reminds the vast majority of employees, nearly all of whom possess exaggerated self-perceptions of their performance, that their current pay is well below where they think it should be. Transparency creates an expanded playground for our comparisons, potentially heightening our attention and obsession with it and elevating the negative emotions and behaviors that result. Admittedly, there is much that remains to be explored about the effects of pay transparency, but the evidence points to transparency elevating three costly responses:

Employees who suddenly discover they are “underpaid” become more dissatisfied with their employer and more likely to depart. Shortly after the University of California began making its employee salaries public, a team of scholars conducted a fascinating experiment. They sent letters to a random set of faculty in the UC system, informing them of a newspaper website they could use to find out the salaries of their peers. A few days later the researchers surveyed all campus employees, asking about their use of the website, their job satisfaction, and their job search intentions. The researchers then compared the responses of those who were informed about the website and those who were not. Most who were informed about it accessed the site and examined the pay of colleagues in their department. The result was that those who were invited to visit the website and discovered they were paid below the median were much less satisfied with their jobs and more likely to express an intent to depart than those who were paid below the median but didn’t receive the prompt to compare their pay. Transparency encouraged dissatisfaction and turnover.

Employees reduce their productivity when consistently reminded of what they perceive as unfair rewards. My colleague Tomasz Obloj, of HEC Paris, and I recently examined the effects of an awards program implemented at a European bank selling small consumer loans. The awards program invited each of the bank’s 164 outlets to compete for an all-expenses-paid, weeklong vacation to an exotic resort. However, the 164 outlets were divided into four tournament groups, and each tournament group competed for a different number of prizes. Those assigned to tournament groups competing for fewer awards felt predictably slighted; the awards program was significantly less effective for these groups. The more interesting finding was that outlets geographically surrounded by or socially connected to other outlets in “better” tournament groups actually decreased their performance — and the magnitude of the reduction corresponded with how physically or socially close these advantaged outlets were. What might this say about pay transparency? The more “in your face” those receiving preferred rewards are, the greater the negative emotions that dampen productivity. It is hard to imagine a policy change that does more to place pay comparison in everyone’s face than pay transparency.

Employees suddenly made aware of their peers’ high pay take up politicking for change. For many years, Harvard managed the bulk of its endowment portfolio with internal Harvard employees but paid them much like fund managers employed by external investment management firms. The performance of these Harvard employees was quite remarkable during the early 2000s. As a result, some of these Harvard employees earned in excess of $30 million in yearly pay, due to performance that was truly exceptional against industry benchmarks. Their superior performance earned billions for Harvard, and all was fine until these pay outcomes became transparent to the Harvard community. This transparency set off a wave of opposition from students, faculty, and alumni alike. All efforts to justify these rewards, based on claims that payments to outside fund managers for such exceptional results would have been greater, fell on deaf ears. Harvard’s president at the time, Larry Summers, relented and flattened pay, pushing several fund managers to leave. Harvard also moved the management of a much larger share of the endowment to external fund managers, including many who had just departed Harvard. Transparency prompted lobbying for change.

Of course, these responses to transparency — departures, boycotts (reduced effort), and active politicking — may be precisely what the advocates of transparency expect and want. The behaviors prompt change, including change that corrects gender-based inequities. However, pay transparency unveils more than real gender-based inequities; it also fuels perceived inequities prompted by inflated self-perceptions. To avoid the departures, reduced effort, and costly politicking that these perceived inequities provoke, organizations must respond to those perceptions. Unfortunately, the managerial remedies are often as harmful as the diseases they attempt to cure:

Organizations can flatten pay. Companies may respond by weakening incentives, essentially dropping any pretense of a link between performance and pay. They may instead reward something like seniority or position, as these are easily observed and verified. Pay transparency thrives in organizations that abandon pay for performance; it struggles in environments where rewards are linked to subjective metrics. Abandoning the link between pay and performance, though, has predictable outcomes: Motivation declines, and the best, brightest, and most capable depart for firms that reward performance and recognize ability.

Organizations can physically and socially separate those with distinct patterns or levels of pay. Organizations can, in essence, isolate the people likely to provoke others to envy (or isolate those with a basis to envy). An executive of a very large industrial manufacturer shared a fascinating illustration with me. The firm housed two distinct employee groups with very different reward structures at a common physical location. One group was a well-paid, well-educated group of client-facing engineers. The other group consisted of production employees operating in a factory setting. Efforts to retain the first group with higher pay were plagued by unrelenting complaints and discontent from those less highly paid. In response, management took a succession of steps targeted at reducing transparency or eliminating the opportunity for comparison. They first attempted to isolate the higher paid group at the same site — constructing a brick wall down the middle of the building, creating separate entrances, and dividing the parking lot — thus limiting transparency. When all of that proved insufficient to quell the negative behavioral responses, they physically moved the high-paid group to a new location, several miles away. Of course, actions taken to separate employees may contradict what is necessary for effective work flow and communication.

Organizations can outsource those activities where competitive rewards demand pay that diverges dramatically from the rest of the organization. For years, large pharmaceutical firms purchased small biotech firms with promises to keep their “entrepreneurial rewards” intact. But the large firms quickly discovered that social comparison processes made this highly problematic. Attempts to maintain these incentives wreaked havoc on the sense of fairness and equity in the remainder of the firm. Yet abandoning these incentives caused key talent — the talent that prompted the big company’s acquisition in the first place — to exit. Big Pharma quickly moved to a model of contracting out research to smaller firms, and then paying to license any discoveries. Of course, the story with Harvard and the management of its endowment echoes this same pattern. Pay transparency pushed Harvard to outsource.

Composing effective reward systems is no simple task. While gender pay inequities merit swift remedy, pay transparency is no panacea. Unless performance is highly transparent, imposing transparency will elevate feelings of inequity that will inevitably push employees to depart, reduce effort, and lobby for change. Remedying gender inequities will certainly be one of those changes, but it’s unlikely to be the only one. Unless you have a clean, clear, and broadly accepted measure of individual performance, transparency will likely push you to flatten pay — linking rewards to factors you can precisely measure, such as seniority or hierarchical position. Of course, rewarding these factors will demotivate and drive away the talent you would like to keep.

What do effective organizations do? They link individual performance to rewards but recognize that they must be vigilant in efforts both to measure performance and to convince employees that their necessarily imperfect measures are acceptably fair. The real problem with pay transparency is that it focuses individuals on comparing pay rather than on elevating performance.

Todd Zenger is the N. Eldon Tanner Professor of Strategy and Strategic Leadership and Presidential Professor at University of Utah’s Eccles School of Business. His recent book, Beyond Competitive Advantage: How to Solve the Puzzle of Sustaining Growth While Creating Value (Harvard Business Review Press, June 2016) explores how value creating corporations compose corporate theories that guide their ongoing growth, including acquisitions. You can download a free chapter at ToddZenger.com.